Economics Journal: Mumbai 2011 – What is the Cost of Terrorism?

What are the economic consequences of acts of terror? Will terrorism affect India’s growth story?

India’s financial and commercial capital was once again a target Wednesday. Three explosions killed almost 20 people and injured scores more. Once again, the attacks raise the question of whether an increased incidence of terrorism will be harmful to India’s economic trajectory.

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Home Minister P. Chidambaram stated at a press conference Thursday morning that one of several major objectives of a terrorist attack is to try to damage India’s rising prosperity. While it’s evident that a terrorist attack has harmful short-term effects on economic activity, by causing death and destruction, what is much less clear is whether it has major long-term impacts as well.

After 26/11 – the assault on Mumbai in November 2008 by Pakistani gunmen — the stock market rebounded quickly and there’s no compelling evidence of a long-term effect on India’s rate of Gross Domestic Product growth. On Thursday, the stock market opened lower, but it’s obviously too early to predict any longer-term effect and as of mid-afternoon it was higher from Wednesday’s close.

However, this does not mean that an increased incidence of terrorist attacks won’t necessarily have detrimental effects in the future. For example, a study of the Israeli economy found that GDP was 10% to 15% lower than it would have been between 2001 and 2003 had there been no terror attacks there. The authors highlight both the direct costs of terrorism induced by the destruction of life and property as well as the indirect costs of diverting resources towards security away from civilian uses.

Arguably, Israel is a special case as a small state that has been highly vulnerable to a large number of terrorist attacks over many years. But using worldwide data spanning many developed and developing countries, researchers at the Milken Institute find statistical support for the proposition that an increased incidence of terror attacks is harmful to economic activity both in the short and long run.

In particular, they point to the detrimental effect on capital formation caused by the fear and uncertainty of a terrorist attack. Capital accumulation is a key driver of long-term economic growth.

There are no comparable systematic studies using Indian data as far as I’m aware, but there’s certainly anecdotal evidence that terrorist attacks, especially centered around financial and commercial districts within Mumbai, instill fear in those who live and work there. It’s surely no accident that the multi-billion dollar diamond industry, which is one important plank of Mumbai’s prosperity, was a principal target Wednesday.

While it’s early days, the experience of terrorist attacks in Mumbai suggests that people will board the local trains and come to work as usual. For many people, it’s not a matter of heroism but an existential struggle for survival.

In a poor country such as India, most people don’t have the luxury of grief but have to get back to work to feed themselves and their families. That is the economic core behind the resilience so often noted by commentators on the response of Mumbai’s residents to previous terrorist attacks.

This most recent attack will surely lead to even more stringent security, as 26/11 did before it. But as Mr. Chidambaram himself pointed out, you cannot lock down every inch of a publicly used commercial space in a democracy such as India.

Nor is it correct to say that the Indian security establishment hasn’t reacted to the threat of terrorism. Mr. Chidambaram, a former finance minister, is certainly aware of the relationship between increased insecurity and a dampening of India’s economic prospects.

Regardless, the tragic reality is that there are likely to be more incidents in the future and this is something that everyone, including investors at home and abroad, are going to factor in.

Israel, with perhaps the best domestic security and intelligence establishment in the world, has not been able to wipe out the threat of terrorism. And as the studies have shown, Israel has paid an economic price.

The threat of future terrorism, both in terms of quantity and intensity, more likely than not, is going to be a negative factor weighing on India’s long-term growth.

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